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 Inheritance tax is starting to be more of a concern to many people.
Most people still do not pay inheritance but more are being dragged into the net because of rising property prices. With sensible planning a lot can however be done to mitigate the effects.
Who is liable to Inheritance Tax?
UK domiciled individuals are caught by IHT on assets they have anywhere in the workd and non-UK domiciled individuals are caught on assets in the UK only.
Exempt transfers
There are a lot of gifts that are exempt from IHT, the more common ones being...
- Small gifts to any person in a tax year not exceeding £250;
- Gifts in consideration of marriage by a parent of £5000, £2500 by a grandparent and £1000 by anyone else;
- Gifts that are part of your normal expenditure out of income and don't reduce your net income below that required to maintain your normal standard of living;
- Annual transfers up to £3000. Any unused amount may also be carried forward for one year only;
- Gifts to charities and registered community amateur sports clubs;
- Gifts to political parties;
- Maintenance payments to ex-partners.
Transfers between Husband and Wife (or civil partners)
No inheritance tax is payable as long as both are domiciled in the UK. This is often used as a basic method of IHT avoidance but it does simply pass the problem onto the surviving spouse. If it is a transfer to a foreign domiciled spouse it is only exempt up to £55,000.
How IHT is calculated
A running total is kept of chargeable lifetime transfers and no tax is payable on these or your wealth at death until you exceed the IHT threshold of £300,000 for 2007/08, to be gradually increased to £350,000 by 20010/11. The sum up to the threshold is commonly known as the nil rate band.
The excess above this is taxed at 40% on death although chargeable lifetime transfers are taxed at 20%, although most lifetime transfers will be potentially exempt transfers.
Any liabilities you have on death as well as funeral costs are deducted in arriving at your estate to tax.
Potentially Exempt Transfers
Most transfer are potentially exempt and so are only subject to IHT if you die within 7 years of making the gift and even then IHT is only payable if it is over the threshold when added to the estate at death and other lifetime transfers in the previous 7 years.
So giving your assets away and hoping to live 7 years is the most basic form of IHT planning, although does of course mean you have lost control of your assets. There is no need to report the gifts when made but the recipient should do so within a year of the donor's death.
There is tapering relief available on a sliding scale for gifts made between 3 and 7 years before death.
Chargeable transfers
Chargeable transfers are not exempt and can incur IHT at the rate of 20% if they exceed the cumulative IHT threshold. They usually only apply on transfers to trusts and companies.
Gifts with Reservation
By giving away say your home to your children this does not automatically exempt you from inheritance tax should you live 7 years. If you are still living in it rent free this is a gift with reservation and will not exempt you from tax. Even if you paid a market rent, it would mean the landlord could be liable for a Capital Gains Tax bill on the property if there is a gain when it is sold.
Pre-Owned Assets Tax (POAT)
In 2005/06 a pre-owned assets tax was introduced to make an income tax charge on people who had given away assets to avoid IHT but who still enjoyed use of them. This can be avoided by electing to have the asset liable to IHT instead. HMRC can now accept late elections for this.
Payment of IHT?
On death IHT is payable 6 months afrer the end of the month in which the death occurs. The personal representatives of a deceased's estate has to pay any tax they are liable for at the time of probate, even if it is before then.
Certain qualifying assets including land and business interests can be paid in equal yearly instalments over 10 years
Business Property Relief
This is a valuable relief for business owners, allowing up to 100% of business interests to be removed from IHT when it has been owned by the donor throughout the previous 2 years. Detailed provisions do apply and there are variations on this for certain business property.
Life Assurance
If you have life assurance and the payout goes into your estate it will form part of your estate for IHT purposes. However, if the policy is written in trust for the beneficiaries it is possible to avoid this and is simple to do.
Policies can also be taken out to cover the IHT on death.
Using trusts to avoid inheritance tax
Trusts do require expert advice to be set-up and allow you to give money away to avoid IHT whilst still keeping a certain amount of control.
Discretionary will trusts can also be used with spouses/civil partners to help avoid IHT and it is relatively straight forward to set these up to ensure both spouses/civil partners IHT nil-rate bands are effectively used after the second death, so saving up to £120,000 in IHT.
How we can help you
We can advise you on your potential exposure to inheritance tax and on the planning you can put in place to minimize it.
Got a Question?
If you have any queries on any of the above, please ask a question
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